Measuring core inflation as the common trend of prices

Abstract

In recent years, many central banks have adopted inflation targeting policies starting an intense debate about which measure of inflation to adopt. The literature on core inflation has tried to develop indicators of inflation which would respond only to 'significant' changes in inflation. This paper defines a measure of core inflation as the common trend of prices in a multivariate dynamic model, that has, by construction, three properties: it filters idiosyncratic and transitory macro noises, and it leads the future leveI of headline inflation. We also show that the popular trimmed mean estimator of core inflation could be regarded as a proxy for the ideal GLS estimator for heteroskedastic data. We employ an asymmetric trimmed mean estimator to take account of possible skewness of the distribution, and we obtain an unconditional measure of core inflation.